WannaLearn: Mutual Fund Basics

If you decide to invest in mutual funds, be sure to obtain as much information about the fund before you invest. And don't make assumptions about the soundness of the fund based solely on its past performance or its name.

Sources of Information

Prospectus

When you purchase shares of a mutual fund, the fund must provide you with a prospectus. But you can — and should — request and read a fund's prospectus before you invest. The prospectus is the fund's selling document and contains valuable information, such as the fund's investment objectives or goals, principal strategies for achieving those goals, principal risks of investing in the fund, fees and expenses, and past performance. The prospectus also identifies the fund's managers and advisers and describes how to purchase and redeem fund shares.

While they may seem daunting at first, mutual fund prospectuses contain a treasure trove of valuable information. The SEC requires funds to include specific categories of information in their prospectuses and to present key data (such as fees and past performance) in a standard format so that investors can more easily compare different funds.

Here's some of what you'll find in mutual fund prospectuses:

Date of Issue — The date of the prospectus should appear on the front cover. Mutual funds must update their prospectuses at least once a year, so always check to make sure you're looking at the most recent version.

Risk/Return Bar Chart and Table — Near the front of the prospectus, right after the fund's narrative description of its investment objectives or goals, strategies, and risks, you'll find a bar chart showing the fund's annual total returns for each of the last 10 years (or for the life of the fund if it is less than 10 years old). All funds that have had annual returns for at least one calendar year must include this chart.

Except in limited circumstances, funds also must include a table that sets forth returns — both before and after taxes — for the past 1-, 5-, and 10-year periods. The table will also include the returns of an appropriate broad-based index for comparison purposes. Here's what the table will look like:

	1-year	5-year (or life of fund)	10-year (or life of fund)
Return before taxes	___%	___%	___%
Return after taxes on distributions	___%	___%	___%
Return after taxes on distributions and sale of fund shares	___%	___%	___%

Index (reflects no deductions for [fees, expenses, or taxes])	___%	___%	___%

Note: Be sure to read any footnotes or accompanying explanations to make sure that you fully understand the data the fund provides in the bar chart and table. Also, bear in mind that the bar chart and table for a multiple-class fund (that offers more than one class of fund shares in the prospectus) will typically show performance data and returns for only one class.

Fee Table — Following the performance bar chart and annual returns table, you'll find a table that describes the fund's fees and expenses. These include the shareholder fees and annual fund operating expenses described in greater detail above. The fee table includes an example that will help you compare costs among different funds by showing you the costs associated with investing a hypothetical $10,000 over a 1-, 3-, 5-, and 10-year period.
Financial Highlights — This section, which generally appears towards the back of the prospectus, contains audited data concerning the fund's financial performance for each of the past 5 years. Here you'll find net asset values (for both the beginning and end of each period), total returns, and various ratios, including the ratio of expenses to average net assets, the ratio of net income to average net assets, and the portfolio turnover rate.

Profile

Some mutual funds also furnish investors with a "profile," which summarizes key information contained in the fund's prospectus, such as the fund's investment objectives, principal investment strategies, principal risks, performance, fees and expenses, after-tax returns, identity of the fund's investment adviser, investment requirements, and other information.

Statement of Additional Information ("SAI")

Also known as "Part B" of the registration statement, the SAI explains a fund's operations in greater detail than the prospectus — including the fund's financial statements and details about the history of the fund, fund policies on borrowing and concentration, the identity of officers, directors, and persons who control the fund, investment advisory and other services, brokerage commissions, tax matters, and performance such as yield and average annual total return information. If you ask, the fund must send you an SAI. The back cover of the fund's prospectus should contain information on how to obtain the SAI.

Shareholder Reports

A mutual fund also must provide shareholders with annual and semi-annual reports within 60 days after the end of the fund's fiscal year and 60 days after the fund's fiscal mid-year. These reports contain a variety of updated financial information, a list of the fund's portfolio securities, and other information. The information in the shareholder reports will be current as of the date of the particular report (that is, the last day of the fund's fiscal year for the annual report, and the last day of the fund's fiscal mid-year for the semi-annual report).

Past Performance

A fund's past performance is not as important as you might think. Advertisements, rankings, and ratings often emphasize how well a fund has performed in the past. But studies show that the future is often different. This year's "number one" fund can easily become next year's below average fund.

Be sure to find out how long the fund has been in existence. Newly created or small funds sometimes have excellent short-term performance records. Because these funds may invest in only a small number of stocks, a few successful stocks can have a large impact on their performance. But as these funds grow larger and increase the number of stocks they own, each stock has less impact on performance. This may make it more difficult to sustain initial results.

While past performance does not necessarily predict future returns, it can tell you how volatile (or stable) a fund has been over a period of time. Generally, the more volatile a fund, the higher the investment risk. If you'll need your money to meet a financial goal in the near-term, you probably can't afford the risk of investing in a fund with a volatile history because you will not have enough time to ride out any declines in the stock market.

Looking Beyond a Fund's Name

Don't assume that a fund called the "XYZ Stock Fund" invests only in stocks or that the "Martian High-Yield Fund" invests only in the securities of companies headquartered on the planet Mars. The SEC requires that any mutual fund with a name suggesting that it focuses on a particular type of investment must invest at least 80% of its assets in the type of investment suggested by its name. But funds can still invest up to one-fifth of their holdings in other types of securities — including securities that you might consider too risky or perhaps not aggressive enough.

Bank Products versus Mutual Funds

Many banks now sell mutual funds, some of which carry the bank's name. But mutual funds sold in banks, including money market funds, are not bank deposits. As a result, they are not federally insured by the Federal Deposit Insurance Corporation (FDIC).

Money Market Matters

Don't confuse a "money market fund" with a "money market deposit account." The names are similar, but they are completely different:

A money market fund is a type of mutual fund. It is not guaranteed or FDIC insured. When you buy shares in a money market fund, you should receive a prospectus.
A money market deposit account is a bank deposit. It is guaranteed and FDIC insured. When you deposit money in a money market deposit account, you should receive a Truth in Savings form.

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